Central Bank Digital Currencies - A Primer on a Cashless Society

In recent weeks, it has become increasingly apparent to me that many people are completely unaware of the concept of a central bank digital currency or CBDC.  In this posting, I will outline the key aspects of CBDC, how it will be implemented and why and will encapsulate all of the things that I have learned about our looming cashless society for your illumination.

  

Let's start by looking at the definition of a CBDC.  

"A CBDC is a form of digital currency issued by a nation's central bank and is equivalent to its physical national fiat currency (i.e the bank notes that are circulated in an economy)."

  

There are two types of CBDCs:

 

1.) Retail CBDCs - these CBDCs will be used by consumers and businesses.  There are two types of retail CBDCs:

 

a.) Account-based retail CBDCs which will require a digital identification to access an account.  These CBDCs could cause disruption in the commercial banking sector and could lead to identifying, tracking and profiling of all end-user's transactions.

 

b.) Token-based retail CBDCs which will be accessible with private keys, public keys or both which will allow an individual to execute transactions anonymously, however, central banks could choose to implement specific identity requirements to access the network, negating anonymity. 

 

2.) Wholesale CBDCS - these CBDCs will be used for transactions by the financial/commercial banking sector.

 

Here is a quote from a study on CBDCs from the European Data Protection Supervisor regarding the definition of a CBDC:

"A CBDC consists of a digital representation of coins and banknotes in the form of digital tokens. It is an electronic file that embodies a specific value with a reference to its owner attached to it. By just changing that reference, the value is transferred and a payment is made. CBDC is usually presented by central banks as a complement to cash, equipped with similar features (notably, having regard to the legal tender status), but adapted to some functional needs and to the ‘digital’ nature referred to above."

 

Some central banks (i.e. the Bank of England) are selling the benefits of a CBDC by stating that while CBDCs will be implemented, bank notes will still remain in circulation (i.e. the payment system will not become entirely digital) however, they give no time frame for the implementation of a fully digital payments system which is certain to follow.

CBDCs could be administered in one of two main architectural ecosystems:

 

1.) the direct model where the central bank provides a direct service to the end user such as a reloadable card or online digital wallet.

 

2.) the indirect model where commercial banks provide the ledger for retail transactions with the central bank maintaining the wholesale ledger of CBDC transactions with the commercial banks.

 

Under a hybrid model of CBDC administration, commercial banks will provide retail services to its customers and the central bank retains a ledger of retail transactions.  According to the Bank for International Settlements (the central bank for central banks), this is currently the architecture that most central banks are currently considering.

 

Here is a graphic showing the two types of CBDC architecture and the resulting data flow:

 

Some people comment that we already have a digital payments system which consists mainly of debit and credit cards.  While this is true, there is a key difference between CBDCs and the current digital payments system.  CBDCs will be legal tender and must be accepted if offered as payment within the jurisdiction of its issue whereas other electronic means of payment (i.e. credit cards etcetera) can be refused.

 

There are at least two issues that will make the implementation of a CBDC ecosystem difficult:

 

1.) Resilience - the CBDC banking system must be resistant to cyber security threats and must operate when the power grid is unavailable.

 

 2.) Privacy - we will have to trust that central banks and governments will not use CBDCs to track and trace our behaviours.  Here is a quote about CBDC-related privacy from a study done by Payments Canada with my bold:

  

"A CBDC with the same level of privacy as traditional cash is highly unlikely. As with cash, privacy may be limited in the service of public safety priorities around money laundering, terrorist financing, tax evasion and parallel market activities, particularly for large CBDC transactions."

  

One might ask, why do we need CBDCs.  Here are some of the reasons given by central bankers:

 

1.) reinforcement of monetary sovereignty, strategic autonomy and monetary policy implementation

 

2.) creation of a more reliable form of payment than new form of private money by private actors (i.e. Bitcoin etcetera) that bypass the existing bank-based payment systems

 

3.) to stimulate competition and innovation in payments, removing barriers and avoiding closed payment

systems created by platforms (i.e. Meta's proposed Diem)

 

4.) to foster financial inclusion, rendering the process easier for people that currently do not have a bank account 

 

5.) to improve cross-border retail payments

 

6.) reduce or eliminate money laundering, tax evasion, fraud and terrorist financing since  CBDC contain features of identifiability of the end-user and traceability of their transactions

Banking inclusiveness is always part of the sales pitch for CBDCs but you wouldn't be the only person who thinks that central bankers really don't care about the unbanked since, in general, they contribute less to the economy than the banked.

Now, let's look at the downsides to CBDCs:

 

1.) lack of privacy - all transactions can be tracked and traced

 

2.) central banks could limit the amounts of digital currency that could be owned by each person/entity

 

3.) a tiering approach could be used where there are no limits to the amount of digital currency that can be held but that amounts above a certain threshold could receive a negative interest rate which would destroy the value of the individual's savings

 

To me, the most frightening aspect of a CBDC is the potential for a programmable digital currency which is defined as a "CBDC with built-in rules, imposing restrictions on the usage of that money."

 

By implementing a programmable money through a CBDC, a government could do the following:

 

1.) define a positive or negative interest rate to incentivise or disincentive the use of money 

 

2.) limit its use to a certain category of services for example placing limits on purchases of alcohol, tobacco, gasoline, meat or other items that the government deems unnecessary or unhealthy.  This could act as a de facto rationing system which would be particularly compelling during a "climate emergency".

 

3.) set a CBDC expiry date which could be used to incentive spending during economic downturns.

 

4.) CBDCs could be linked to an individual's social credit system by way of a digital identity.  If an individual has views or behaviours that are contrary to what the current government powers believe are acceptable, this could be considered when CBDCs are issued to an individual.  In this case, CBDCs could be used to promote or impede social and political changes. 

 

The development of CBDCs is being undertaken by many nations around the world and implementation is at various stages as shown on this CBDC tracker from the Atlantic Council:

 

 

Effective in September 2024, 134 nations and currency unions representing 98 percent of global GDP are exploring a CBDC with 66 nations currently at an advanced stage of development.  Three nations have launched a full-fledged CBDC with varying results; Nigeria and its e-Naira which launched in October 2021, the Bahamas and its Sand Dollar in October 2020 and Jamaica with its Jamaican Digital Exchange or JAM-DEX in May 2022.

 

Let's close with this commentary about CBDCs from Agustin Carstens, General Manager of the Bank for International Settlements, once again, the central bank for central bankers:

  

That tells you all that you need to know about CBDCs and how they will be used.

It is my belief that the "boiling frog" analogy is most apt when it comes to the issuance of CBDCs.  With the vast majority of the world currently exploring the development of a central bank digital currency, we are slowly but surely being led down the garden path to a cashless society where transactional privacy is non-existent and governments will have the ability to use a heavy-handed approach to curtailing what they believe is unacceptable behaviour by their citizens through the implementation of programmable digital currencies in conjunction with a digital identification program.   All that it will take is some sort of crisis in the world’s financial markets to give the powers that ought-not-to be the excuse that they need to send the sweaty masses down the road to monetary slavery.